merged

Study Guide for Chapter

Study Guide for Chapter 27 Chapter Summary for Chapter 27 The economic efficiency rule is to produce the quantity of output where marginal social benefit equals marginal social cost. Market failure occurs when the market does not produce the optimal quantity of output. One cause of market failure is a lack of perfect competition. Externality is a benefit or a cost of an activity that affects third parties. When an externality is generated, the private market will fail to produce the optimal quantity. Private market equilibrium will occur where the private market demand curve intersects with the private market supply curve (where marginal private benefit equals marginal private cost). If a market generates an external benefit, the private market will underproduce compared to the optimal quantity. The private market equilibrium (where marginal private benefit equals marginal private cost) will be less than the optimal quantity (where marginal social benefit equals marginal social cost). If a market generates an external cost, the private market will overproduce compared to the optimal quantity. The private market equilibrium (where marginal private benefit equals marginal private cost) will be greater than the optimal quantity (where marginal social benefit equals marginal social cost). There are four methods for controlling externalities. An externality can be internalized by; (1) persuasion, (2) establishing private property rights and reaching voluntary agreements, and (3) taxes and subsidies. Externalities can also be controlled through government regulation. Government regulation may result in costs that exceed benefits because; (1) government regulations are generally imposed on a blanket basis, (2) government regulations are sometimes imposed without careful comparison of costs and benefits, and (3) government regulations impose costs on the economy. Pollution is any undesired byproduct of production. The economically efficient level of pollution is usually not zero. The cost of reducing pollution to zero is usually greater than the benefit of achieving zero pollution. Pollution control should be pursued up to the point where the marginal social benefit of control equals the marginal social cost of control. The government has relied mainly on two methods of pollution control; (1) regulatory standards, and (2) market environmentalism. Private goods are rivalrous in consumption and excludable. Public goods are nonrivalrous in consumption and nonexcludable. Because a public good is nonexcludable, consumers can obtain the benefit of the good without paying for it. This is the free rider problem. Thus, public goods must be produced by government. Common goods are rivalrous in consumption and nonexcludable. Because a common good is nonexcludable, consumers will tend to overconsume a common good. This is called the tragedy of the commons. The tragedy of the commons can by analyzed as an externality problem or as a type of prisoners’ dilemma. One way to solve the tragedy of the commons is to turn the common good into a privately owned good. Another way to solve the tragedy of the commons is by government regulation or taxation. Another source of market failure is asymmetric information. Asymmetric information may result in adverse selection. Asymmetric information may result in moral hazard. Economists disagree on how severe a problem is created by asymmetric information. Some economists see asymmetric information as a major flaw in the market system. Other economists argue that information is usually available, though at a cost. FOR REVIEW ONLY - NOT FOR DISTRIBUTION 27 - 11 Market Failure